The unconventional methods


-Editorial

WEB DESK: The International Monetary Fund (IMF) has endorsed unconventional monetary policies of European and Japanese central banks though the emerging markets, particularly the Governor of the State Bank of India, warned that such policies are increasing the costs as opposed to the benefits. Conventional economics dictates that through manipulating key interest rates, including interbank rates, the central bank controls the liquidity in money markets and thereby delivers on its primary responsibility to keep inflation low in the medium-term.

In advanced countries under normal circumstances the central bank does not directly lend to the private sector or the government or indeed purchases government bonds, or any other type of debt instrument. However, unconventional monetary policy dictates expansion of central bank credit to deal with a persistent financial crisis; and the advantage of such an unconventional measure that allows central banks as opposed to financial institutions to extend credit is that it can elastically obtain funds by issuing riskless government debt, according to Gertler and Peter Karadi of New York University.

Lorenzo Bini Smaghi, Member of the Executive Board of the European Central Bank, in a keynote lecture at the International Center for Monetary and Banking Studies (ICMB), Geneva on 28th April 2009, stated that unconventional measures can be implemented in three ways: First, direct quantitative easing for which he cited the Bank of Japan’s policy as an example.

This policy involved: (i) a shift in the operational target for money market operations from the uncollateralized overnight call rate to the outstanding balance of current account deposits at the Bank of Japan, or in short the bank reserves; (ii) outright purchases of Japanese government bonds to meet the target balance of current account deposits at the Bank; and (iii) an explicit, public commitment to maintain these open market operations until the inflationary rate falls on an unsustainable basis.

Second, direct credit easing and the example was of the US Federal Reserve approach since December 2007 whereby it established several lending programmes to provide liquidity and improve the functioning of key credit markets that included (i) Term Auction Facility designed to ensure that financial institutions have adequate access to short-term credit; (ii) Commercial Paper Funding Facility that provides a backstop for the market for high-quality commercial paper; and (iii) in cooperation with the US Treasury Department to purchase asset-backed securities such as mortgage securities backed by government-sponsored enterprises.

Larry Summers, former US Treasury Secretary, recently wrote that “today’s risks of embedded low inflation tilting towards deflation and of secular stagnation in output growth are at least as serious as the inflation problem of the 1970s… In all likelihood, the important elements will be a combination of fiscal expansion drawing on the opportunity created by super low rates and, in extremis, further experimentation with unconventional monetary policies.” Thirdly, indirect quantitative/credit easing and the ECB was cited as an example which adopted a ‘fixed-rate full-allotment’ procedure which allows access to unlimited liquidity for periods ranging from one week up to six months at a fixed rate.

Smaghi added that “we implicitly eased monetary conditions further by expanding the list of assets eligible as collateral in Eurosystem refinancing operations. This feature of the Eurosystem’s collateral framework, together with the fact that access to Eurosystem open market operations is granted to a large pool of counterparties, has been key to supporting the implementation of monetary policy in times of stress.”

Rajan, the Governor of Reserve Bank of India, argues that competitive quantitative easing would pose a risk to growth and the financial sector and supported stronger and well capitalised multilateral institutions that could provide “patient capital”. And proposed a group of academics to measure and analyse the spillover effects of unconventional monetary policies.

To conclude, it is unlikely that advanced countries would abandon their unconventional monetary policies especially where they have been successful in combating deflation. But as Smaghi states, an exit policy may not be that easy with reference to (i) devising the right sequence for the phasing out of the conventional and unconventional monetary policy accommodation; and (ii) deciding on the speed at which the unconventional accommodation is removed.

Source: Business Recorder